You should only invest borrowed money if your borrowing cost is cheaper than the investment return, you have high confidence, and you are in a strong financial position.
Borrowing to invest can be a strategic financial leveraging situation that addresses tax advantage or intention to make a higher return than the interest paid on borrowings.
Key Takeaways
- Investing borrowed money requires low risk high return option
- Leveraging works for asset building and getting tax rebate
- You need to pay interest on borrowed money regardless of your investment return
- You may make your DTI ratio worse by borrowing
- The inability to pay loans will worsen your credit score
When borrowing to invest can be a good idea?
Borrowing to invest is feasible when you expect a higher return than the borrowing cost, your financial position supports investment risk and there are tax benefits that can pay you trough tax credits or rebates.
If the interest rate on the borrowed money is lower than the expected return on the investment, leveraging (investing borrowed money) might be profitable. For example, if you can borrow at 4% and expect an 8% return, the net gain can be attractive.
Furthermore, leveraging might make sense if you have a high level of confidence in your investment, such as in real estate or a stable blue-chip stock. But, you should always evaluate the risk of your investment especially if you are borrowing to invest. We never suggest taking loans and investing the amount into the crypto business as it requires anticipation skills and sufficient risk coverage.
You may invest your borrowings for tax advantages. There are certain countries where the interest on borrowed money used for investments might be tax-deductible, potentially making the strategy more appealing. For example, in the United States, the IRS allows individuals to deduct investment interest expense, which is the interest paid on money borrowed to purchase taxable investments. The IRS publication 550 provides detailed information about the tax treatment of investment income and expenses, including the rules for deducting investment interest.
When should you avoid borrowing to invest?
You should not invest borrowed money when your borrowing cost is higher than the expected investment return, you lack expertise and your financial situation is not as good to absorb any losses.
If the borrowing costs are high, the potential returns might not justify the risk. You must carefully calculate your APR and compare it to your expected return on investment. You also need to crosscheck the frequency of your investment return. For example, your investment must allow you a monthly return or, there should be an alternative way to finance your monthly loan payment on time. Otherwise, your credit score would be under threat.
Similarly, leveraging for high-risk or volatile investments can lead to significant losses, especially if the market moves against you. So it is important to ensure that you know what you are doing.
Moreover, if you have unstable income, high existing debt, or lack an emergency fund, borrowing to invest can put you in a precarious financial situation.
Lastly, if you’re not confident in your investment knowledge or strategy, leveraging can amplify potential mistakes.
What should you consider before investing?
You need to carefully consider your risk tolerance, investment timeframe, diversification, and exit strategy.
Consider the below things if you are going to make borrowings to invest.
- Assess your risk tolerance honestly. Leverage can amplify both gains and losses, and it’s crucial to be prepared for the possibility of losing the borrowed capital.
- Long-term investments might benefit more from leverage, as they have more time to recover from short-term volatility.
- Ensure that your investment is well-diversified to spread the risk.
- Have a clear exit strategy in place. Know when and how you will repay the borrowed funds, even if the investment doesn’t perform as expected.
Why should you invest your loan money?
In my opinion, you should invest your loans either to build & grow your wealth or, investing lender’s money can be your long-term financial strategy.
Borrowing to invest has become an increasingly common strategy as individuals seek to leverage their financial positions to maximize returns. According to the Federal Reserve Bank of New York, total household debt in the U.S. reached $184 billion in the first quarter of 2024.
Furthermore, home equity lending is projected to grow by 3% in 2024 compared to the previous year, indicating that homeowners are tapping into their home equity to access funds for investments. This is a clear indication that people are trying to utilize borrowed money to build wealth for future security.
Leveraging or, investing the borrowings can also become a long-term strategy. For example, if your loan capacity is $10,000 per year, you can aim to invest $3,000 out of your available credit limit to something you are almost sure about the return. I had a friend who invested half of his credit into a drop shipping business and made a 10 times higher return. He knew what was he doing. He made a website, optimized it nicely sourced products from China to Newyork and earned as an intermediary.
Later on, he accumulated $100,000 and invested the amount into real estate and again multiplied the money multiple times within 5 years.
But, side hustles require exceptional skills.
Where should you invest your borrowings?
To be very honest, low-risk investment options such as real estate, coupon bonds, treasury bonds, low-risk mutual funds, and secured private equity investments can make sufficient returns to pay back your borrowing costs.
In a nutshell, you should only choose an investment option that is comparably risk-free and offers you timely payment with sufficient margin.
Here are a few investment options you might consider to utilize your borrowings:
- Certificate of deposits (CD)
- Bonds
- Treasury bond
- Margin
- Government bonds
- Blue chip stocks
- Real estate
- Low-risk mutual funds
- Lending to poor credit relatives
Investing in a loan can make a high yield through a certificate of deposit (CD) offered by banks. Certificates of deposit are low-risk, fixed-term investments offered by banks. They provide a guaranteed return over a specified period, making them a safe choice for conservative investors looking to preserve capital.
You may consider investing your loans into bonds (those are less risky). U.S. Treasury bonds, municipal bonds, and other government securities are considered low-risk investments. They offer fixed-interest payments and are backed by the government, making them a reliable choice for conservative investors. Additionally, bonds from highly rated, well-established companies (investment-grade bonds) offer higher yields than government bonds while maintaining relatively low risk. Look for bonds from companies with strong credit ratings.
In some countries, where the private sector’s credit growth is upward moving, private banks often allow others to invest for the short term. Usually, treasury bonds by commercial banks can be for a minimum of three months and offer greater returns compared to government securities. You can also try treasury bonds if you can manage 3 month’s loan payments from other sources since the return from a treasury bond gets after the maturity.
Investing in blue-chip stocks, which are shares of large, reputable companies with a history of stable earnings and dividend payments, can be a safer way to use borrowed money. These companies tend to be less volatile and provide regular income through dividends. additionally, broad-market index funds and exchange-traded funds (ETFs) that track major indices like the S&P 500 provide diversification and lower risk compared to individual stocks.
Similarly, investing in rental properties can generate steady income and potential capital appreciation. Real estate investments are generally considered safe, especially in stable markets with high demand for rental properties.
Lastly, money market funds such as mutual funds and other short-term investment securities can also be a good choice to invest borrowed amounts, but for a shorter period.
You may also consider investing in margin with your borrowings. allows you to buy more stock than you could with just your available cash. Essentially, you’re using leverage to increase your investment potential. However, there is a significant risk with margin calls. If the value of your securities drops below the maintenance margin level, you’ll receive a margin call. You must then quickly deposit more funds or sell securities to cover the shortfall, which can lead to forced sales at unfavorable prices.
If you have a close relative who needs money but does not have a good credit score, you may reinvest your money by re-lending to him. It will surely increase your risk but there would be a high return as well. Make sure that you know the person well and you have alternative ways to get your money back.
The below table exhibits the rate of return of several investment options, plus their respective risk level (you should only choose one that offers a higher return and is within your risk appetite)
| Investment Option | Average Annual Return (%) | Risk Level |
|---|---|---|
| Government Bonds (10-Year Treasury) | 3.8 | Low |
| Corporate Bonds (Investment-Grade) | 4.5 | Low-Medium |
| Blue-Chip Stocks (Dividend Yield) | 2.5 | Medium |
| Rental Properties (Cap Rate) | 5.0 | Medium |
| REITs (Dividend Yield) | 4.0 | Medium |
| Certificates of Deposit (1-Year) | 1.0 | Low |
| Money Market Funds | 0.5 | Low |
What are the high-risk investments?
When it comes to investing borrowed money, high-risk investments such as cryptocurrency or secondary market shares should be approached with extreme caution, or better yet, avoided altogether. These high-risk ventures, while potentially offering significant returns, can just as easily lead to substantial losses, jeopardizing not only your initial capital but also leaving you with debt.
First off, steer clear of cryptocurrencies and speculative stocks. Cryptocurrencies, like Bitcoin and various altcoins, are notoriously volatile, experiencing wild price swings that can wipe out investments overnight. Similarly, speculative stocks—those tied to companies with unproven business models or those in highly volatile sectors—can be tempting but are incredibly risky. Additionally, initial coin offerings (ICOs) and penny stocks, often touted as low-entry investment opportunities, are rife with fraud and market manipulation. Betting borrowed money on such uncertain outcomes is akin to gambling with funds you can’t afford to lose. Always prioritize stability and predictable returns over the allure of quick, high gains.
Bottom line
First of all, you should only borrow if there is a clear pathway to the fund utilization. You are okay to invest the borrowed amount if you have the necessary financial strength to bear the investment risk and the return on investment is higher than your borrowing cost.
Good luck
